We all get excited when looking to purchase a business. Whether it's because we can sense an opportunity, a better lifestyle or increased disposable income, it's crucial that any decision to purchase is made with our eyes wide open.
Here are 5 quick tips to consider when looking to purchase a business.
1. Why Do You Really Want To Buy A Business?
Before going down the path of buying an enterprise, list down the reasons why it is that you actually want to buy the business in the first place. Be aware that most businesses are hard work and may mean long hours particularly when getting it to the humming stage. If you think a business means a better lifestyle than a 9 to 5 job, that might be true but be prepared to put in the hard yards for the first few years at least.
List down the pros and cons of being a small business owner. Talk to others that have their own venture and find out what they like, dislike about what they have.
If you think that the business can make you more money than what you are earning now, check the numbers and the potential to ensure you reach the desired minimum goal. This will usually involve some sort of business plan and 3 way cash flow budget.
2. Do You Understand Business Value?
Having been a business valuer and small business accountant for many years I've seen a variety of ventures and know what will drive value up and what will drive value down.
Most businesses will be valued higher if their risk is lower. The higher the risk the less you should be paying.
Risk is usually considered by looking at areas such as:
- History of profits;
- Cash flow strength;
- Owner reliance;
- Customer or Supplier reliance;
- Systems and processes;
- Industry potential;
Figure 1: Ca n you really see what the business performance is showing or hiding?
3. Is The Business On The Way Up Or Down?
If the business is seen to be contracting whether it be in revenue and or profits, it's imperative that you find out why and have it verified. Generally a business that is contracting will have a lower business valuation than one that is consistent or on the way up as often you will have to invest more in people, plant, technology or even marketing to get it to an acceptable level to where you want it. This means doing your homework and determining what monies will need to spent in the coming weeks, months and years to make the venture viable and successful.
Of course, if the venture is solid and has been showing a trend for continuing upwards, ensure this trend is sustainable. If it is, generally you will pay more as there will be less to invest afterwards and the risk of such a trend not continuing should be minimal.
Figure 2: It pays to do your homework first!
4. Common Traps
Some things that can cause a business purchase to be a disaster:
- Purchase price was determined using cash or unreported figures (danger!);
- Customers only want to deal with the current owner;
- Figures were not verified (e.g. monies from the vendor's other businesses were being injected into the P&L hiding the true performance;
- Over reliance on a few customers (what if they leave or go broke?);
- Paying too much for plant or obsolete stock;
- Using a multiple of "3 times" on the EBIT (basically this is profit - earnings before interest and tax) or the wrong valuation method without checking;
- Not adjusting EBIT for unusual income or expense items that won't be there in future or reasonable salaries for owners and family making the profits look higher than what they really are;
- Key employees taking customers with them when they leave;
- No restraint of trade on the vendor;
5. Consider Advice From Professionals
If you are going to buy a business it makes sense to get proper advice from experienced accountants, business valuers and solicitors.
Spending a few dollars at the start could help you avoid a very expensive purchase that could also cause massive financial grief. Of course they might also be able to assist you to understand what the true value is and the risks involved.
Making sure that the value is reasonable and what business structure you should be looking at for yourself and legal matters is paramount.
If you are considering buying a business aware of the risk and reward so you can correctly identify potential to do well.
Some of the tips above are very handy but there are many more things to consider when making such a substantial investment and lifestyle choice. Having said that, these are just some of the basics.